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Debt to Equity. Toolkit 6 Row 2C in Section 2. Jim Hurt Director, Central Iowa Chapter. Disclaimer.
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Debt to Equity Toolkit 6 Row 2C in Section 2 Jim Hurt Director, Central Iowa Chapter
Disclaimer • The information in this presentation is for educational purposes only and is not intended to be a recommendation to purchase or sell any of the stocks, mutual funds, or other securities that may be referenced.
Outline of Class • Where do we see D/E and D/C? • Define debt and equity. • Why use debt? • Debt to equity (Toolkit 6 Row 2C). • Debt to Capital (Online SSG). • Relationship Between D/E and D/C.
Two Related Terms • Will discuss both: • Debt to Equity. • Debt to Capitalization. • These two terms are closely related. • They both measure how much debt. • Both appear in Toolkit 6. • Online SSG uses only Debt to Capitalization.
Where Do We See These? • Toolkit (all versions) Top of Side 1 of SSG
Where Do We See These? • Toolkit 6 Debt / Equity Side 2, Section 2, Row 2C
Online SSG Debt / Capital Tab 2: Evaluate Management Step 4: % Debt to Capital
Definition of Debt • Debt is what the company owes and has to pay interest on, such as: • Loans from banks. • Company bonds. • Preferred stock. • Short term debt has to be paid in the next twelve months. • Long term debt has to be paid later than the next twelve months.
Definition of Equity • Assetsare everything that the company owns at that moment. • Liabilitiesare everything the company owes at that moment. • Equityis assets minus liabilities. • Also calledshareholder's equity. • Also called net worth. • Also called book value. • Also called retained earnings.
Why Use Debt? • When the interest rate is lower than the return on total capital, borrowing money will increase return on equity. • This is a good thing.
Debt to Equity Ratio • Compares debt to equity. • Equals debt divided by equity. • Also called D/E, Leverage, Risk, or Gearing. • Indicates what proportion of equity and debt the company is using to finance its assets. • Toolkit 6 uses Long Term Debt and Shareholder’s Equity for row 2C.
High Debt to Equity • A high debt to equity ratio means the company has been aggressive in financing its growth by borrowing a lot. • This can result in volatile earnings as a result of the additional interest expense. • In hard economic times, too much debt can lead to bankruptcy.
How Much is Too Much Debt? • For manufacturing and retail companies, we BetterInvestors like to see Debt to Equity below 50%. • Financial companies run much higher Debt to Equity (e.g. 900%). • Like to see D/E even or down with time. • Toolkit 6 Row 2C.
What if D/E is Increasing? • If D/E is increasing, find out why! • Is the company borrowing the money for valid reasons? • Valid reasons will increase assets, such as: • Acquisition. • New products. • New factories.
What if D/E is Increasing? • If you do not like the reason(s) the money is being borrowed, drop this company. • You do not like the acquisition. • You do not think new product will sell. • Read Annual Reports to find out why company was borrowing money.
Definition of Capital • Capital is the funds that the company can use for financing projects and other operations. • It is equal to Equity plus Debt. • Also called Total Capital. • Banks use a different definition. • Not to be confused with Market Capitalization!
Debt to Capital Ratio • Comparing debt to total capital. • Calculated by dividing debt by the sum of debt and equity. • Measures the fraction of all assets that have been paid for by borrowing. • Also called D/C or DC.
BI Advice on Debt to Capital • We like to have companies use some leverage. • But not too much leverage! • Want DC to be below 33%. • But compare this debt ratio to that of the company's competitors. • Banks are special (DC around 90%).
Relationship Between D/E and D/C • D/E is Debt divided by Equity. • D/C is Debt divided by the sum of Equity and Debt. • D/E of 50% is the same debt as DC of 33.3%.
